Q: Are student loans tax deductible? How can college students save on their taxes?

A: The federal government offers several tax breaks for students and their parents. Be sure to consult your tax advisor to determine whether you may take advantage of any of these incentives.

Education Loan Interest DeductionIf you are making loan payments, you can deduct up to $2,500 in interest payments on one or more qualifying education loans.

Interest paid while a loan is not in repayment (such as forbearance or deferment) is also deductible. The deduction is an adjustment to income; you can claim it even if you do not itemize tax deductions.

You cannot claim the deduction if your parents claim you as a dependent on their taxes. Eligibility is phased out for unmarried taxpayers with annual gross income of $55,000 to $70,000 (and $110,000 to $140,000 for joint filers).

HOT TAX TIP: If parents are making student loan payments on behalf of their child, the child can benefit greatly from a tax perspective. Generally, you can only deduct student loan interest payments if you, personally are legally required to repay that debt. However, if parents make student loan payments for their child, the IRS treats it as though the money was given to the child, who in turn paid the debt. In this way, a child who is not claimed as a dependent can qualify to deduct up to $2,500 of the student loan interest paid by mom and dad. And the student does not have to itemize to use this money-saver!!! This is a huge benefit if you can take advantage of it.

HOPE and Lifetime Learning Tax CreditsThese programs reduce the amount of your federal taxes based on qualifying out-of-pocket educational expenses paid for yourself, your spouse or your dependent child. Qualifying out-of-pocket expenses include tuition and fees less any grants and scholarships received. It does not include room, board, books, and transportation.

Only one taxpayer (either the student or the parent) may claim this tax credit. Also, only one of these tax credits may be claimed per tax year.

HOPE Tax Credit: With this credit, you can claim a tax credit of up to $1,650 for each qualifying family member who is attending an eligible school.

That amount represents 100% of the first $1,000 of your out-of-pocket educational expenses for each student, plus 50% of the next $1,000.

The student must be in the first or second year of a degree or certificate-granting program and must be attending at least half time.

Lifetime Learning Tax Credit: With this credit, you can claim a maximum credit of up to $2,000 (20% of the first 10,000). This credit is calculated per family, not per student.

The maximum credit is the same, no matter how many family members are in school. You can claim this credit at any time during enrollment at an eligible school. The student needs only to be enrolled in one course.

Are Scholarships and Grants Taxable Income?The way the IRS looks at it, only money used toward tuition, fees, books, supplies and equipment required for your courses is considered non-taxable.

Any grant or scholarship money used for other purposes (like housing, for example) is considered taxable and needs to be reported.

Calculate the portion of your financial aid to be included in your taxable income by adding up your total grant aid and subtracting out the cost of tuition, fees, books, supplies and equipment required for your courses of instruction.

According to IRS Publication 970, a scholarship or fellowship is tax free if you are a candidate for a degree at an eligible educational institution, and you use the scholarship or fellowship to pay qualified education expenses.

For purposes of tax-free scholarships and fellowships, these are expenses for tuition and fees required to enroll at or attend an eligible educational institution, and course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution.

(To be considered tax-free, these items must be required of all students in your course of instruction.)

However, in order for these to be qualified education expenses, the terms of the scholarship or fellowship cannot require that it be used for other purposes, such as room and board, or specify that it cannot be used for tuition or course-related expenses.

Qualified education expenses do not include the cost of room and board, travel, research, clerical help, or equipment and other expenses that are not required for enrollment in or attendance at an eligible educational institution.

Are Student Loans Taxable Income?Funds from student loans are not considered taxable income and should not be included as income on your income tax return. A student loan is not income because you must repay the amount borrowed plus interest. However, if any of your student loan debt is forgiven, the amount forgiven would be income in that year. Some students have student loan debt forgiven for teaching or participating in other forms of public service.

More ResourcesFor more information on these incentives see the Taxpayer Relief Act of 1997 or the Economic Growth and Tax Relief Reconciliation Act of 2001.